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10 Feb, 2024 08:53

Fintech face-off: How India’s central bank cracked the whip on e-wallet giant Paytm

The survival of the startup that drove financial inclusion in the country and boosted the nation’s economy is now at stake
Fintech face-off: How India’s central bank cracked the whip on e-wallet giant Paytm

In baseball, it’s three strikes and you’re out. Vijay Shekhar Sharma, founder of Indian digital payments company Paytm, and arguably the country’s largest startups poster boy, faces a possible third strike. Like football’s video assistant referee (VAR), the match official is in the process of making a decision.

On January 31, the Reserve Bank of India (RBI) – the country’s central bank and also banking regulator – ordered Paytm Payments Bank Limited (PPBL) to stop accepting fresh deposits in its accounts or digital wallets from March onwards.

It said a Comprehensive System Audit report and subsequent compliance validation report by external auditors had revealed persistent non-compliance and continued material supervisory concerns in the bank, warranting further supervisory action.

These concerns include: failure to identify beneficial owners; a lack of monitoring and risk profiling for payout transactions; breaching regulatory balances; delayed reporting of cyber security incidents; failure in its Video Based Customer Identification Process (V-CIP); and the failure of its servers to prevent connections from IP addresses outside India. Following this, the RBI asked the bank to explain why penalties shouldn’t be imposed.


Digital banking and the paradigm shift

In India, payment banks are stripped-down versions of banks that cannot issue credit but can accept cash deposits of up to 200,000 rupees ($2,400) per customer. PPBL is a part of the Paytm brand, housed under One 97 Communications.

Paytm’s extensive user base has facilitated collaborations with financial institutions, enabling loans, credit cards, the sale of insurance products, and even online gaming and betting.

The concept of e-wallets started gaining traction in India with the emergence of online payment gateways like BillDesk and CC Avenue. However, these were primarily focused on facilitating online transactions for merchants. From 2010 onwards, companies such as Paytm, MobiKwik, and FreeCharge began offering e-wallet services in India. These platforms allowed users to store money digitally and make payments for various goods and services such as online shopping.

In 2014, the launch of the Unified Payments Interface (UPI) by the National Payments Corporation of India revolutionized the country’s digital payment landscape. While not strictly e-wallets, UPI-based apps like Google’s GPay, Walmart’s PhonePe, and Paytm’s payment bank integrated e-wallet features alongside bank account-linking, and enabling payments.

This gave a significant thrust to India’s financial inclusion landscape, which underwent a significant transformation with the inception of the so-called ‘JAM Trinity’ – comprising ‘Jan Dhan Yojana’ (National Mission for Financial Inclusion) for universal banking access; Aadhaar, or a 12-digit unique identity number, for unique biometric identification; and Mobile services, for direct transfers.

As users came on board, with the help of Paytm and others, the concept of payments banks came into play, which are primarily digital entities established by the RBI to advance financial inclusion. This involves various types of insurance, as well as loans to a vast majority of people who earn less than $10 a day.

Both payments banking in 2014 and the Digital India campaign in 2015 proved significant for roping the unbanked population into the mainstream economic system with a formal financial net.

The World Bank’s 2021 financial inclusion report on India stated that account ownership more than doubled from 35% in 2011 to 78% in 2021. In particular, between 2014 and 2017 account ownership in India increased by 27% compared to 8% in developing economies.

Repeat offender?

This is not the first time that PPBL has had a run-in with the regulator. This followed years of non-compliance with central bank rules, including customer due diligence, the use of funds, and technology infrastructure, according to a Reuters report. Since 2016, the regulator has been keeping an eye on Paytm.

In October 2023, the RBI imposed a monetary penalty of Rs 5.390 billion ($65 million) for non-compliance with certain provisions. Earlier, on March 11, 2022, it barred PPBL from onboarding new customers.

Paytm counts Berkshire Hathaway, Japan’s SoftBank, and China’s Ant Financial among its early investors. Since the RBI announcement, the company has seen a value erosion of $1.2 billion. Sharma launched Paytm more than a decade ago and its usage turbocharged in 2016, after India banned its erstwhile high-denomination currency notes.

Despite Paytm’s response and oral submissions, the RBI found non-compliance and imposed monetary penalties. The January 31 action might prove to be the last straw.

Fintech face-off: How India’s central bank cracked the whip on e-wallet giant Paytm

Areas of concern

Global finance has become a different f-word for many regulators across the world. The US Senate, its Securities and Exchange Commission, and parliamentarians in Europe are among regulators that have moved away from the lenient approach that prevailed during the heyday of globalization.

Indian regulators have taken a similar approach. The RBI’s move stems predominantly from safeguarding the financial system at a time when the Indian economy is poised to become the world’s third largest by 2030.

“Earlier, India had cracked down heavily on crypto-currency transactions to curb any cross-border anti-money laundering transactions. Now it’s time to tighten the individual’s wallets’ Know Your Customer (KYC) and Anti-Money Laundering (AML) regime,” says Kapil Khandelwal, managing partner at El Toro Finserve LLP, a leading investment manager of several funds investing in Indian healthcare infrastructure, sustainability, and impact funding.

“Hostile nations that intend to push India on to the FATF [Financial Action Taskforce] negative list are also watching Indian regulators’ actions closely. Moreover, money managers and their senior management teams should also adopt stringent diligence like the UK’s Financial Conduct Authority (FCA) Register.”

Resolution or desolation: What’s next?

Whenever such situations arise, Indians tend to look at alternatives – quickly. In this case, stakeholders, most notably merchants, have already stopped accepting Paytm-associated payments and are moving to alternatives such as the Walmart-owned PhonePe or Google’s GPay, among others.

The Confederation of All India Traders (CAIT) on February 4 issued a cautionary advisory to traders to switch from Paytm to other options for business-related transactions.

“The RBI has imposed certain restrictions, prompting CAIT to recommend that users take proactive measures to protect their funds and ensure uninterrupted financial transactions,” CAIT said in a statement. “Large number of small traders, vendors, hawkers and women are making payments through Paytm and as such RBI restrictions could lead to financial disruption.”

Further, banks that have no skin in the game at present will not budge until the RBI’s concerns are addressed by Paytm. “In such scenarios, the RBI has never allowed things to fade away. They will talk to other providers or formulate a takeover or transition plan so that various stakeholders are not short-changed,” says Mohan Lavi, partner at K.P. Rao & Company, a Bengaluru-based audit firm.

The situation became interesting when media reports speculated that billionaire businessman Mukesh Ambani’s Jio Financial Services was in the race to buy Paytm. Both companies deny this.

To understand what could happen next, one needs to look at the February 6 meeting between Sharma and India’s finance minister, Nirmala Sitharaman. The Paytm chief executive was told the government has no role to play in connection with the latest RBI restrictions, according to an NDTV report.


Further, according to sources in the know, Paytm could be under investigation by India’s Enforcement Directorate (ED), a specialized financial investigation agency under the jurisdiction of the Department of Revenue of the Ministry of Finance. It is responsible for enforcing economic laws and fighting economic crime in India. Paytm claims there is no investigation. 

So far, brokerage houses have given a thumbs down. JPMorgan cut Paytm’s rating from “neutral” to “underweight.” Jefferies downgraded Paytm’s stock from “buy” to “underperform,” saying regulatory and reputational issues could affect profitability. Morgan Stanley analysts on February 2 said they expect Paytm revenue forecasts to fall 6% for FY25 and 8% for FY26, reflecting a scaling down of the wallet business.

For its part, Paytm has tried to assuage concerns. In a call with analysts, the company said it is confident that in the worst-case scenario, the EBITDA (earnings before interest, taxes, depreciation and amortization) impact will be 3-5 billion rupees ($36-60 million). It said it would ‘make good’ of this in the medium term, though timeline details were not specified. This EBITDA impact assumes the wallet business is scaled down to negligible levels.

Paytm’s payment bank, which holds all 330 million of Paytm’s wallet accounts, is pivotal to the company’s app and wallet ecosystem. In many ways, Paytm was the leading Indian fintech company and its continued failure to comply led to the regulator’s recent order – seen as an action before canceling Paytm’s payment bank license, thereby bringing down the curtain on one of its promising lines of business.

It also signals others in the industry to clean up their act; the sooner, the better.

Analysts are concerned that the central bank’s directive may lead Paytm’s lending partners to reassess their relationship with the company, given its 49% ownership of the payments bank, potentially impeding Paytm’s journey toward achieving net profitability.

While it is still too early to judge the entire episode, foreign investors will welcome regulations and proportionate enforcement actions that are uniformly applied across the entire ecosystem. On the other hand, if enforcement is selective and disproportionate, it will inhibit the development of the fintech ecosystem.

“Once the dust settles down on this episode it will be clear whether Paytm management was reckless in repeatedly ignoring compliance issues, in which case they should be punished, or whether RBI regulations are so onerous that even a well-resourced publicly-listed company is unable to discharge its legal obligations in a sustainable manner. In which case regulations must be reviewed by taking into consideration industry’s feedback,” says Santosh Pai, partner at Dentons Link Legal and honorary fellow at the Institute of Chinese Studies.

So far, Sharma has put on a brave face and has given the impression that he is working with regulators. “You are a part of the Paytm family, and there is nothing to worry about. Many banks are helping us,” he said. “We are not completely sure of things… like what exactly went wrong. But we will figure out everything soon. We will reach out to the RBI to see what can be done.”

In an effort to show better regulatory compliance, on February 9, the Board of One 97 Communications announced the formation of a three member Group Advisory Committee chaired by former SEBI Chairman M. Damodaran.

According to the RBI, as of January 6, six payments banks are operational in India – apart from Paytm, these include two payments banks owned by telecom providers Airtel and Jio, one started by India Post, as well as Fino Payments Bank and NSDL Payments Bank. Sharma has famously said: “If you’re up against a big guy, ignore the big guy.”

Whether this approach continues to be prudent, time will tell.